Legal hurdles, not Amazon, key concern for U.S. dental supply firms

(Reuters) - Henry Schein Inc and Patterson Cos Inc have bigger things to worry about than Amazon.com Inc potentially disrupting the niche dental-equipment market they dominate in the United States.

Their stocks, as well as those of other U.S. drug and medical equipment suppliers, have taken a beating in the past year as speculation over Amazon expanding its considerable reach gained momentum.

But investors and analysts told Reuters that the larger overhang on the two dental suppliers, and privately held Benco Dental Supply, is a recent complaint filed against them by the U.S. Federal Trade Commission.

The complaint alleges that the three companies broke antitrust law by conspiring to refuse discounts to dentists. The administrative trial is scheduled to begin on Oct. 16.

The trial could last years, and even a quick settlement could force the companies to ramp up discounts to customers and in turn pressure their margins, investors and analysts said.

“I think for now I would avoid investing in that particular industry, and kind of keep a careful watch,” said Michael Arone, chief investment strategist at State Street Global Advisors, which owns shares in Henry Schein and Patterson.

All three companies have issued public statement denying the FTC’s allegations. Patterson declined to comment further.

Henry Schein, in a letter it sent customers on Thursday, said the FTC was “essentially asking us to stop doing something that we believe we never did in the first place.”

A spokeswoman for Benco Dental said the company expected "to fully resolve this issue in a way that clarifies the integrity of our people and processes." (bit.ly/2FlQLof)

SETTLEMENT LIKELY

Henry Schein shares have lost nearly a fourth of their value, while Patterson’s stock is down 30 percent since May, roughly when speculation of Amazon’s entry into their market started.

After Henry Schein reported quarterly results on Tuesday, several analysts cut their price targets on its stock, mainly due to the risks associated with the FTC complaint.

“While the FTC allegation is for injunctive relief and seeks no monetary damages or fines, there is no clear timeline to a resolution of the matter,” Evercore ISI analyst Ross Muken said in a research note.

He lowered his rating on Henry Schein to “in-line” from “outperform” and said he expected gains in the company’s stock to remain muted until further clarity on the complaint, possibly in late 2018 or early 2019.

The companies are likely to settle, legal experts said.

In a similar complaint in 2015, a small Meridian, Idaho-based provider of drug-and-alcohol testing services settled with the FTC months after the regulator filed a complaint alleging the company was colluding with a rival to keep prices high. (bit.ly/2opA7Ma)

Antitrust lawyers, however, said the FTC’s complaint against the dental suppliers was more serious than usual and did not rely on just circumstantial evidence.

“It appears the FTC has evidence of an explicit agreement between at least two of these so-called competitors and that is a stronger case than what you often typically see,” said Nicholas Gravante, an antitrust lawyer at Boies Schiller Flexner. Gravante is not involved with the complaint.

Still, Wall Street analysts mostly remain bullish about these companies’ businesses, even with the looming threat of Amazon, which they said could take a while to play out.

Last week, the Wall Street Journal reported that the ecommerce giant was looking to expand its business-to-business marketplace that already sells professional medical products and hospital consumables such as gloves.

Analysts said the dental companies were shielded by their long-standing relationships with dentists, while their narrow-margin business model may make it tough for Amazon to undercut them.

“I think Amazon is certainly a threat, certainly a negative, but not to the extent to which stocks like Henry Schein sold off,” said Kevin Kedra, an analyst at Gabelli & Co.

Gabelli owns less than 1 percent of Henry Schein shares and about 2 percent of Patterson.